Opening Remarks by Mr Jaseem Ahmed, Secretary-General of the IFSB at the Regulator’s Forum 2016 – Islamic Finance in 2016 and Beyond: Challenges, Opportunities and Evolving Regulatory Focus

I would like to extend a warm welcome to distinguished speakers and panellists, and also to the audience here today, which comprise, the stakeholders of the global Islamic finance industry many of whom are members of the IFSB. I appreciate your presence and look forward to your active participation in this Forum.

In my opening remarks I will address two issues. These are, first, recent regulatory developments both globally and within Islamic finance. And second, I will share with you some results from the IFSI Stability Report 2016.

Ladies and gentlemen, as you are aware, in line with international developments, the IFSB has in recent years launched a series of post-crisis prudential standards and guiding principles that align global regulatory developments with the specificities of Islamic finance, while also assisting national financial sector supervisors to provide a level playing field for IIFS vis-à-vis their conventional counterparts.

Globally, regulatory reforms have focussed on moral hazard and risk taking by banks by mandating higher quality of capital, and higher levels of capital on the funding side. On the asset side, there is a corresponding focus on the quality of liquid assets. To this has been added a macro-prudential perspective that stresses proactive measures to monitor the build-up risks through robust supervision and stress testing. Finally, there is a heightened emphasis on the consistency of implementation of reforms internationally.

The IFSB’s Work Plan in recent years has placed a high priority on putting in place standards encompassing higher and better quality capital and liquidity buffers, and an increased focus on macroprudential regulation.

• For instance, in April last year, the IFSB had released IFSB-17, its Standard on ‘Core Principles for Islamic Finance Regulation (Banking Segment)’ which complements the Basel Core Principles for Effective Supervision by modifying them to suit the specificities of Islamic finance, and also introducing four new Core Principles (Sharī’ah governance, treatment of PSIA, equity investment risk, and Islamic windows) taking the tally to 33 as compared to Basel’s 29 Core Principles.
• The IFSB also released its Guidance Note 6 (GN-6) which covers aspects of liquidity coverage ratio, definition of high-quality liquid assets, treatment of profit-sharing investment accounts (PSIA), net-stable funding ratio, monitoring tools and disclosure requirements, from the perspectives of the specificities of Islamic finance.
• This year, in December, we expect to release our Technical Note 2 (TN-2) on Stress Tests for IIFS which aims to provide RSAs and market players of the Islamic banking industry with appropriate and adequate technical guidance to develop, conduct and assess stress tests.

♦ IFSI in 2016 and Beyond – Key Findings of the IFSB Stability Report 2016.

Allow me now to present some key findings of the Stability Report 2016, which will be released shortly today by H.E. Deputy Governor Dr. Hendar from the Bank of Indonesia.

First, from an overall perspective, since the global financial crisis, the IFSI has grown at double-digit rates, outpacing growth and performance of the conventional sector. However, 2015 witnessed a decline in this growth rate, at least in terms of the growth rate of assets in Islamic banking and Islamic capital markets. In fact, the focus of the IFSI stakeholders’ has now switched to measuring the resilience and stability of the IFSI as international ratings agencies warn of rising risks in 2016.

Islamic Banking

Second, turning to the banking sector, there are reasons for both concern regarding profitability as well as for guarded optimism in view of capitalisation levels.

• The number of countries where Islamic banking is systemically important (i.e. where it accounts for more than 15% of total banking assets) has increased to 11.
• It is noteworthy that 84% of the global sukūk outstanding are also concentrated in these 11 markets.
• However, as the size of Islamic banking assets shows a positive association with oil revenues, the liquidity and profitability of Islamic banks may be adversely impacted by low oil prices.
• At the same time, IIFS appear to be sufficiently capitalised to absorb the additional risks, and they have reduced concentration risks by scaling down exposure to real estate and energy projects.
• Finally, for the banking sector, Liquidity management remains a prime challenge, especially in jurisdictions where no active Sharī’ah-compliant interbank market has emerged.

Islamic Capital Markets

Third, Islamic capital markets have been subject to volatility related to the increasing internationalisation of Islamic finance, but there do not appear to be reasons for a disruption in their long term outlook. The critical issue for monitoring in the short term is the impact on balance sheets of banks of changes in yields on sukūk, which the IFSB’s stress testing simulations finds can be adverse in some circumstances.

• The most striking adverse developments in ICM in 2015 include contractions in returns and asset values. The volume of sukūk issuances also dropped by more than 50% in 2015 after the Malaysian central bank terminated its regular issuances of short-term sukūk.
• In terms of structural features, the sukūk market is still dominated by sovereign and multilateral issuers (70% of all issuances in 2015).
• The global corporate issuances from Gulf Cooperation Council (GCC) countries were primarily by IIFS (including three perpetual Additional Tier-1 sukūk), while issuers in Asia (in particular, Malaysia) come from a wider range of industries, such as construction, transportation and retail.
• Regulatory reforms such as Basel III, as well as IFSB-15 and Guidance Note 6 (GN-6) are expected to lead to an increased demand for highly rated sukūk that meet regulatory requirements.
• The share of short-term sukūk has decreased, while that of sukūk with maturities of three–five years and five–ten years increased to 22% and 39%, respectively, in 2015.
• The sovereign sukūk sector may gain momentum in 2016 on the back of increased budget deficits, particularly in the energy-exporting countries.
• Although there has been no instance of a sukūk default since 2010, a strengthening of legal frameworks and regulations regarding sukūk resolution in default cases could facilitate more international sukūk issuances.

Takāful (Islamic Insurance)

Fourth, the takāful sector performance was relatively strong in 2015.

• Three jurisdictions account for 84% of the global takāful contributions: Saudi Arabia (37%), Iran (34%) and Malaysia (14%).
• The structure of their takāful sectors differs fundamentally: while nearly two-thirds of the contributions are for family takāful (with a strong savings/investment component) in Malaysia, this business line is virtually non-existent in Saudi Arabia and Iran where non-Life (e.g. medical/health or motor) is dominant.
• The resilience of investment-linked family takāful is quite high, as investment risks are largely passed on to the takāful participants.
• Price competition had undermined the resilience of general takāful in the past, but recent advances in solvency regulations and the expansion of compulsory motor and health insurance have improved its robustness.

Emerging Issues in Islamic Finance

Stability Report 2016 also discusses some emerging issues related to the IFSI, and I will just touch on two issues: cross sectoral links, and regulatory consistency.

The Global Financial Crisis (GFC) showed the critical role that cross-border financial flows can play in transmitting and amplifying shocks in one market to other financial markets and then to the global financial system.

Analyses of the GFC produced new insights on cross-sectoral and cross-border transmission and contagion channels that are, in principle, also relevant for Islamic finance. However, sufficiently detailed data on cross-sectoral and cross-border transactions in the IFSI have not been collected systematically.

Therefore, the chapter on cross-sectoral links between various sectors of the IFSI and the implications for systemic stability is only a first introduction to the topic. It offers a rough comparison of structures of conventional and Islamic finance and a few conclusions regarding systemic stability. The most important cross-sectoral links with potential relevance for systemic stability are those between Islamic banking and the Islamic capital market – in particular, the sukūk market.

While this indicates the channels through which contagion could flow, the small size of the sukūk market makes it unlikely that a crisis in the sukūk market could trigger a crisis in Islamic banking and hence induce a systemic crisis. A contagion from the much smaller takāful sector is even less likely.

Regulatory Consistency Assessment Programme. Finally, there is today a focus on the full and consistent implementation of regulatory standards within an internationally agreed time frame as an essential prerequisite for strengthening the resilience of the financial system. This applies in particular to the risk based capital and liquidity standards that are known collectively as Basel III.

The FSB and BCBS, IOSCO and IAIS launched a concerted programme to assess and ensure consistency and completeness in the implementation of these prudential standards. While this programme was designed for conventional finance, its basic ideas and approaches are also relevant for Islamic finance. The IFSB has studied in detail the processes and procedures of the BCBS’s Regulatory Consistency Assessment Programme (RCAP) for banking, and the assessment and monitoring programmes of IOSCO and IAIS for capital markets and insurance, respectively.

The IFSB will examine the feasibility of developing its own assessment programme – for example, by thematic reviews on various issues such as risk-weighting of credit risk exposures in Sharī’ah-compliant products and contracts (including profit-sharing contracts), capital adequacy standards for الصكوك, securitisations and real estate investments, and the treatment of profit-sharing investment accounts in the calculation of regulatory capital.

♦ Conclusion

Let me now conclude my remarks by once again thanking all the participants who are here today. I am confident that your deliberations will be productive and that it will provide us at the IFSB and our wider stakeholders with a set of discussions and conclusions that will enrich our work, and further strengthen the global IFSI.

Thank you.